Interest on Interest and Capitalising Interest - the Facts

Diagram of Structure as attached.
 

Attachments

  • LOE Structure v1.doc
    99 KB · Views: 1,546
Last edited:
OK, so I have a few questions stemming from the Word doc.

1) When you receive rent it is not the total rent, it will be minus management fee's, repairs, strata, etc.. Is it right to think that from the PM's statement you can reimburse your rental income A/C these costs from the Property A/C?

2) So if I have three investment properties, A, B and C. Each property has a standard IO loan attached to it used to purchase the properties. Each property also has a LOC attached to it which was used to either help purchase one of the properties or to purchase income producing assets. Property C then jumps in value, I take out an additional LOC (Property A/C), I then use this LOC (Property A/C) to pay my interest for each of the loans (IO and LOC’s). The interest incurred on the LOC (property A/C) is deductible and I can capitalize this interest and it is still deductible?

3) I am planning on LOE in the near future but it was my understanding that I would have to record my non deductible and deductible debt very carefully, but from what you are telling me everything property related (not PPOR) will be deductible. I would then setup another LOC to support my extra LOE life style, this LOC wouldn't be deductible and as it is another LOC I wouldn’t have to be concerned about making sure I claim my deductible and non deductible debt in the correct portions as the whole portion of the loan would be non deductible. Basically I think you are suggesting LOR (Living Off Rent) without the draw back of having to sell properties to make everything +CF?

Am I on the right track or have I missed something:confused:
 
Cheeks said:
1) When you receive rent it is not the total rent, it will be minus management fee's, repairs, strata, etc.. Is it right to think that from the PM's statement you can reimburse your rental income A/C these costs from the Property A/C?

No you cant do this.

Cheeks said:
2) I then use this LOC (Property A/C) to pay my interest for each of the [investment] loans (IO and LOC’s). The interest incurred on the LOC (property A/C) is deductible and I can capitalize this interest and it is still deductible?

Yes, that is correct.

Cheeks said:
3) I am planning on LOE in the near future but it was my understanding that I would have to record my non deductible and deductible debt very carefully.

Yes, this is correct. You have to separately account for personal expenditure and investment expenditure.


Cheeks said:
but from what you are telling me everything property related (not PPOR) will be deductible.

Where you incur an expense (including interest) in the process of generating income then those expenses will be deductible.


Cheeks said:
I would then setup another LOC to support my extra LOE life style, this LOC wouldn't be deductible and as it is another LOC I wouldn’t have to be concerned about making sure I claim my deductible and non deductible debt in the correct portions as the whole portion of the loan would be non deductible.

You can have the one LOC and account for private and investment proportions (like I showed you in the first post of this thread) or you can have another LOC. Whatever is easiest for you and your situation.

Cheeks said:
Basically I think you are suggesting LOR (Living Off Rent) without the draw back of having to sell properties to make everything +CF?

Lets not confuse things by using statements like Living Off Rent :)

You are merely channelling income into one spot and offsetting this where possible against lifestyle choices like a PPOR and personal expenditure

And capitalising all expenses that you incur in the process of generating income in accordance with relevant sections of the tax act.

The drawdown (transfer) from the Line of Credit to the Rental Income A/C would only be necessary if what is sitting in the Rental Income A/C was not sufficient to meet your lifestyle requirements and that interest would not be deductible.

Living Off Equity is the whole structure itself and not any one step of the process.

Otherwise, yes as you said - your next option would be to sell your assets and live off the cold hard cash - and erode your future earnings (capital and income) as a result.

Cheeks said:
Am I on the right track or have I missed something:confused:

Sounds like you are :)
 
Last edited:
Originally Posted by Cheeks
1) When you receive rent it is not the total rent, it will be minus management fee's, repairs, strata, etc.. Is it right to think that from the PM's statement you can reimburse your rental income A/C these costs from the Property A/C?

Originally Posted by Corsa
No you cant do this.

So what you should be doing is arranging with your PM for any repairs and strata fee's to be paid directly by yourself.

Originally Posted by Corsa
Lets not confuse things by using statements like Living Off Rent

:D Just wanted to make the link so that people could see the LOE is a big topic with many strings to the bow, but yes you are right, this can get a little confusing :D

Now, using the LOE spreadsheet James posted on here I have produced the following Graphs.

One being the standard LOE and one being Corsa LOE.

Using a portfolio of 3M and debt of 2M with a return on assets of 100K. The LOE spreadsheet shows that borrowing for lifestyle (50K) per year would leave you with about 4.5M debt after 20years. The Corsa spreadsheet shows a debt of about 5M after 20 years.

Now I understand that the lifestyle costs are not tax deductible but let’s say you get 50% back from the Corsa model, you are still around 250K behind.

I would like to point out that this all depends on your situation but based on the two models and numbers you are better to pump all the rent into running your portfolio and using debt to finance lifestyle.

Again I may have missed something so all comments are welcome :)
 

Attachments

  • Corsa LOE.xls
    43 KB · Views: 663
  • LOE.xls
    43 KB · Views: 584
Cheeks said:
I would like to point out that this all depends on your situation but based on the two models and numbers you are better to pump all the rent into running your portfolio and using debt to finance lifestyle.

This is the same premise by which I've modeled my chosen CGA strategy upon. The rental income is purely used to cover IP portfolio holding expense costs whilst the Equity created from the Portfolio Asset Base is drawn down upon to provide a Tax Free income for lifestyle & investment purposes.
 
Without getting too detailed, my thoughts are it is the concepts that are important here ie the big picture of how the portfolio is structured.

I dont really want to go down the path of saying we will be $20,000 better off under one model vs another model :) That plus I think that at essence the LOE strategy is the same strategy - well at least the one we keep throwing up on Somersoft it just gets very confusing because you can set it up in a few different ways.

Take Hart's case for example, they were trying to maximise their tax situation by channelling the whole loan repayment of a split loan into the personal side and capitalising the interest side and they ended up being in the courts for Tax Evasion - they were capitalising interest - just had the set up wrong. I don't think anyone here wants that to happen.

Cheeks said:
Now, using the LOE spreadsheet James posted on here I have produced the following Graphs. One being the standard LOE and one being Corsa LOE.

Cheeks said:
Now I understand that the lifestyle costs are not tax deductible but let’s say you get 50% back from the Corsa model, you are still around 250K behind.

There is no need to really separate these two concepts. James was just showing the forum how if you did LOE then you would be better off if your properties were growing at a greater rate than your loan balances.

James calculation takes your opening loan balance plus rental income less property interest less lifestyle income = closing balance. This new closing balance loan is then offset against the growth in the properties to come up with your new equity position. As long as that number is increasing you are ahead and that is without taking into account tax benefits.

Cheeks said:
I would like to point out that this all depends on your situation but based on the two models and numbers you are better to pump all the rent into running your portfolio and using debt to finance lifestyle.

I am actually saying exactly the opposite to that :)

The structure that I have put forward on how to capitalise investment costs and interest and how to structure your portfolio is on the premise that you channel investment income into personal accounts to offset your personal debt if you have it and fund lifestyle and to use debt to fund your investment portfolio because that maximises your tax situation.

And then in later years when you stop working, if your investment income is not sufficient to fund your retirement then use debt to fund the gap (based on equity in your portfolio) but this wont be tax deductible.

I am recommending this in leiu of having to sell properties to finance PPOR debt or personal items and instead of using rents to offset investment income although if you did this that would be fine.

Lets just say you do it the way you are saying and you pump rent into running your portfolio and use debt to finance lifestyle - there is no tax benefit in doing that - and more importantly if you still have a debt on your PPOR or want to fund a holiday or luxury item and you have to use debt to finance that - that would not be as preferrable to the strategy I am recommending. BUT either way is fine because you are still living off your properties but one way is more tax effective than the other.

Cheeks said:
Again I may have missed something so all comments are welcome :)

I must be creating some confusion if you dont understand the big picture of what I am proposing but at essence I think you do understand the LOE strategy which is the main thing.
 
Hiya,

Corsa, this is a brilliant thread and a tremendous effort on your part. Kudos to you. :)

I will not intrude on the basis of the thread, as I doubt I can add much of value beyond the sentence in this post. However, I would like to mention that the spreadsheet I created was, as you say, a very basic model with little practical purpose other than to demonstrate how the LOE concept might work for those who have no idea. In no way should it be used as an accurate forecasting or planning tool, much as I am flattered by the idea ;)

Again, thank you Corsa for a fantastic series of posts. You are an incredibly valuable member of this forum.

Cheers

James.
 
Compounding interest is something that I and millions of other small businessmen, small proprietory companys and the blue chip investment companies have done forever.

Every month the loan I set up to finance my new venture requires a payment. So I pay it as required but that payment comes from my overdraft. Oops, that repayment of my 7.5% loan generated a corresponding debt in my 8,5% overdraft. Am I compounding interest?

So I transfer some cash from my LOC to my cheque account to prevent going over the limit. Simply shifting interest liability.

That big cheque arrives so I bank it into my cheque account and immediately transfer some into my various accounts, including my personal credit card and savings account. These payments will show as partner's or director's wages. The rest is apportioned to the most pressing bills. The thought that all debts must be paid before owners/investors can be recompensed is ludicrous. With the exception of a few miners, all ASX listed companies pay dividends while maintaining debt.

Call me simplistic, but that is compounding interest.
 
Last edited:
Hi RichardC

Yes, you are on the money.

Not everyone is familiar with the term compounding interest but in essence that is what we are doing.

Simple is good - its easier to understand :)

Best Wishes

Corsa
 
Corsa said:
Scenario 1
  1. LOC secured by your PPOR
  2. You use this LOC to fund another investment property costs - LOC interest deductible
  3. You use this LOC to fund another investment property interest repayment - LOC interest deductible
  4. You use this LOC to fund your overseas holiday - LOC interest not deductible

Scenario 2
  1. LOC secured by your Investment Property
  2. You use this LOC to fund another investment property costs - LOC interest deductible
  3. You use this LOC to fund another investment property interest - LOC interest deductible
  4. You use this LOC to fund your overseas holiday - LOC interest not deductible

Best Wishes

Corsa :)

Corsa,


While using an LOC account to fund an investment expenses account or loan account...we are saying the LOC interest is deductable.

My question is.. are regular repayments required to pay the LOC interest or is this interest able to accrue and compound without reduction. Interest on interest?

I am aware that most LOC's wouldnt allow no repayments. If this is the case interest payments from income will have to be made.

MJK:D
 
Thanks Corsa

Thanks for the simple and clear explanation Corsa.
It has confirmed what I believed to be correct but my (ex) accountant did not. I am using this approach now and am in the initial stages of moving my accounting and tax affairs to Dale.

Regards,
Chris.
 
Corsa said:
[*]You use this LOC to fund your overseas holiday - LOC interest not deductible
But if an investor also has a margin account with unused margin, can one use this to pay off the credit card?

Thommo.

ps. This is not of direct interest to me. I don't do it.
 
Last edited by a moderator:
RichardC said:
But if an investor also has a margin account with unused margin, can one use this to pay off the credit card?

Thommo.

ps. This is not of direct interest to me. I don't do it.


depends which credit card - if the credit card is the one used for IP or business related expenses, then that should be fine and interest on the margin loan would still be deductible...

If its the credit card used for personal expenditure, then no, well not if they want the margin loan interest to still be 100% deductible ...

remember its not the security that is relevant but the purpose of the funds ....

well thats my educated guess - as always get professional advice :p
 
Last edited by a moderator:
RichardC said:
But if an investor also has a margin account with unused margin, can one use this to pay off the credit card?

Thommo.

ps. This is not of direct interest to me. I don't do it.

Yes, you can do this Thommo.

As Bort points out, the interest on the Margin Loan facility specific to the credit card payment will be deductible depending on what the purpose of the credit card transactions were for.

Investment = deductible Margin Loan Interest
Personal = non deductible Margin Loan Interest
 
Last edited by a moderator:
A case regarding this method

I visited my accountant yesterday and ask him whether this method is allowed. My accountant told me that recently there is a case using this method being ruled illegal by the commissioner of tax. I remember he mentioned something like the Hart's case?? Do any of you know any about this case?

What the argument point is the rental income generated by the IP must go towards paying the outgoing costs (interest, fees, maintenance cost). If the rental income is not enough to cover the outgoing costs, then any money borrowed (and its interest) to cover the shortfall could be tax deductible. Please correct me if my accountant is wrong.
 
fgler said:
What the argument point is the rental income generated by the IP must go towards paying the outgoing costs (interest, fees, maintenance cost). If the rental income is not enough to cover the outgoing costs, then any money borrowed (and its interest) to cover the shortfall could be tax deductible. Please correct me if my accountant is wrong.

mmm ... yet another take

you are really saying that you are only allowed to capitalise interest & expenses for the net loss :
net loss = (interest + expenses) - rent


Can you provide an ATO reference that states this ?
 
Back
Top